Who Snagged the (Micro) Chip Bowl: Is It Time to Worry About a Semiconductor Shortage?

If you’re in the habit of plugging into financial news every day, you’ve likely come across numerous warnings about potential inflation. Maybe you’re starting to get worried because you know that next to food and toilet paper, electronic devices make up the third-most crucial necessity to modern existence; cars may come in next.

And if inflation is about to rear its ugly head, might it make our digital devices and cars less affordable? Although the prices of these products aren’t showing signs of any tremendous increases, there’s a shortage in the very thing that drives them: semiconductors—the brains of pretty much all things electronic—and perhaps the most essential staple of the modern economy. That can’t be good.

So, what’s behind this shortage, and might it eventually cause some sort of cost-push inflation (econo-speak for rising input costs getting passed along to consumers) in electronic products? Or will it just mean that fewer gadgets and even cars will be on the market?

Supply Getting Wafer-Thin

A hard year of pandemic lockdown and economic uncertainty made cash (and toilet paper) stashing, social isolation, and cabin fever an everyday routine. Not surprisingly, there’s a lot of pent-up demand for products that’ll help people survive or escape the quarantine dread. The problem is that most of those products, which happen to be electronic, rely on semiconductor chips. And there aren’t enough chips to go around.

Apple (AAPL) said it can’t seem to find enough chips to meet iPhone demand. Advanced Micro Devices (AMD) apparently can’t get enough of them to meet Microsoft’s (MSFT) Xbox and Sony’s (SNE) PlayStation 5 console demand. And now that automotive demand is heating up as vaccine rollouts seem to be accelerating the end of the lockdown period, car manufacturers like General Motors (GM), Ford, (F), Honda (HNDAF), and Toyota (TM) are warning the chip shortage is holding up production.

The semiconductor industry has long been a somewhat-reliable economic barometer. That’s because it takes about a year to make a semiconductor chip. So, chipmakers have to be pretty accurate when it comes to forecasting demand by at least a year in advance. Such forecasts work under “normal” circumstances. But given the on-again/off-again trade war with China and the pandemic-related supply-chain disruptions, the economy—and chip industry—have been hit with a double whammy.

How the Trade War Snagged the Chip Bowl

If you’re not entirely familiar with the semiconductor supply chain, here’s a 30,000-foot overview:

• Chipmakers like Nvidia (NVDA) and AMD design the chips but many chipmakers don’t necessarily make them.
• The designs get shipped to “foundries,” like China’s Semiconductor Manufacturing International (SMICY), prior to the Trump administration’s restriction, or its rival—and world’s largest contract chipmaker—Taiwan Semiconductor Manufacturing Company (TSM), to make the physical product.
• Once the chip is produced, China has been one of the main countries assembling either the packaging surrounding the chip or the final device.

As you can imagine with the last two points, the trade war with China really didn’t help all that much. The supply chain hit a snag. But what came next would amplify the shortage in supply in an unprecedented global surge in demand—the coronavirus pandemic.

COVID-19 Has Driven Surge in Demand for Electronic Devices

When economies across the globe began quarantining, the demand for at-home technologies and home-based entertainment systems—namely, mobile phones, computers, laptops, digital notebooks, gaming consoles, and smart televisions—became crucial tools for business survival, homeschooling, and cabin fever therapy. 

The problem is that all these devices need semiconductor chips, and there weren’t enough to satisfy the surge in demand. And on top of the production slowdown, the pandemic lockdown not only swelled demand, but it also prevented workers from congregating in office spaces, and with that, semiconductor foundries. Double whammy, indeed.

What Does This Mean for Chip-Dependent Gadgets in 2021?

When short supply collides with high demand, prices tend to explode upward. Several chip foundries have already begun notifying customers that prices are going up. For some, like TSM and Samsung (SSNGY), it’s due to over-demand and having to operate near 100% capacity, according to The Elec, a Korean electronics industry news site.

So, why not hire more people and add more machinery? That too can be expensive and slow to implement. Besides, the industry is already coming off “a record investment year,” according to Risto Puhakka, president of industry analysis firm, VLSIresearch. Yet the increase in demand is occurring at a rate that’s too fast for the optimal production speed. Remember, it takes a long time to produce chips (which is why it has always been viewed as a longer-term barometer for the economy).

Now, the big question: If manufacturers are having to pay more for chip components, will that cost bump-up be transferred to us—the consumers?

The answer is that it’s up to the company manufacturing the product whether you’ll see a product hold-up or a price hike on your electronic devices or new cars. You might even see both, varying from product to product.

How Might This Impact Semiconductor Stocks?

Although several analysts are forecasting the semiconductor shortage to last well into the latter half of 2021 and possibly into 2022, to get a clear forecast on the industry, you may have to break it down and delve into the details.

For example, although chipmakers are trying to find a balance between fewer sales and raised chip prices to compensate for the slack in their profit margins, it also depends on which foundries they’re working with, because some may add capacity sooner than others. Also, chips for mobile phones, computers, and consoles differ in design from those developed for the automotive industry.

Although supply constraints may cap chipmakers’ upside potential, there seems to be no slowdown in demand for digital devices for work or entertainment. With vaccine rollouts underway, it appears that demand for cars has begun to snap back.

Ultimately, the impact of tight supply and high demand on semiconductor stocks, which remains debatable, may likely vary from chipmaker to chipmaker. As a whole, however, the Philadelphia Semiconductor Index’s (SOX) year-to-date market performance (as of late February) shows it leading both the S&P 500 Index (SPX) and the S&P Technology sector (IXT). See figure 1 below.

Supply may be running low, but people have still been crowding the chip bowl.